Capital preservation is a term that gets thrown around alot, what does it mean? |
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Capital preservation refers to an investment strategy in which a primary goal is to avoid the loss of the investment’s total value. In the past, this usually referred to investing in bonds, index funds, and other slow-growth vehicles that attempted to achieve small, consistent growth while having few drawdowns. These days, though, smaller, more nimble portfolio management has changed the investing landscape; making capital preservation a priority no longer means that you must settle for mediocre returns.
By Michael Weiss The concept behind capital preservation is that risking your principal investment for the sake of risky potentially returns hurts, because getting back to even requires a much higher percentage gained than your percentage lost. Got tied up with a risky investment and lost 20%? You’ll need to make a 25% return to make that all back. At the extreme end, if your investment drops 50%, you’ll need to double what you have left just to get back to square one! Compare this to if you had placed your money in a simple, low-risk savings account or bond. Even if you returned 25% a year from there on out – which would be a miracle, honestly, after such a big plunge – it would take you almost three years to match what a 5% annual yield gave you in the first year. So that means you should forsake risky assets and preserve your capital with some slow-growth mutual funds and blue-chip stocks, right? Not necessarily. Savings accounts and bonds will have no risk of drawdowns, but for good reason. Their miniscule returns can hardly be expected to beat inflation over time, let alone build substantial wealth. Diversified mutual funds, index funds, and blue-chip stocks seem like attractive propositions because they are linked to long-standing institutions that almost always grow in value over time. Don’t think that alone will protect your capital, though. The market is cyclical in nature and everything in it, even the market as a whole, can experience prolonged drawdowns. The S&P 500 is usually considered a reliable grower, but the recent bear market has caused it to fall nonstop for the first half of the year, to the tune of a 11% drawdown. Worse still, supposedly rock-solid investments like Microsoft and Berkshire Hathaway have had extensive drawdowns of 40% or more. So it seems like no asset is safe, and buy and hold strategies fail to properly protect your capital. So what is there to do? It turns out that the easiest way to avoid big drawdowns is simple: don’t own the stock when it drops. Alternative investment vehicles these days are available in the form of small, actively-managed portfolios that are liquid enough to exit positions quickly. A stop-loss order is a good idea; it makes sure you don’t get attached to attractive potential profits and sell before things get really bad. Your best option is probably to find a money manager who makes capital preservation a top priority. With qualified professionals tracking your investments around the clock, you can take advantage of active management to get the low downside of slow-growth investments but the upside of more risky assets. You’ll handily beat inflation over time, all the while compounding your capital to build and not just maintain your wealth. |